The Carbon Tax We Had To Have

After five years of delay and division, our nation’s leaders (well, a bare majority of them, anyway) have finally faced up to the devastating risks threatening our future, and done something about it. At long last we have a comprehensive, plausible and sound basis for reducing Australia’s stunningly high levels of pollution.

There is already plenty of excellent explanation and analysis of yesterday’s announcement, and so I won’t address the nitty-gritty details of the package directly. Rather, I’m going to examine it from a number of different angles: the policy mechanisms underlying the scheme’s operation; why it’s better than the CPRS; why it’s a surprisingly fair and democratic policy; some of its weak spots; and finally its implications for the politics of climate.

But firstly, "what’s the point of all this?", as Tony Abbott asked in his press conference yesterday.

Let’s go back to first principles. The world is warming, rapidly and dangerously, because of greenhouse gas pollution.

Unfortunately, climate change is an inherently global problem, and only concerted global action can slow it. Like any international agreement, this will be hard-won and tough to negotiate. Australia, as a middle-power nation in a world of pollution giants, cannot force our peers into reducing their carbon footpoint and saving the planet. All we can do is persuade, charm, convince and cajole. So we had better be able to show convincing proof of our determination to act on climate change.

This, in a nutshell, is why we need a carbon tax. It’s also why yesterday’s policy announcement is an historic day for Australian democracy.

Why the scheme will work
The general concept of pricing pollution is not a new idea. It was first proposed by British economist Arthur Pigou in the 1930s, and forms the basis of all modern attempts by economists to draw up policies to prevent damage to broader society form the so-called "negative externalities" of industrial activity. Pricing carbon pollution therefore forms the central core of carbon policy, and it’s an idea that few serious thinkers on the subject contest.

The carbon price will be set at $23 a tonne, which will begin the work of the key tool of markets, the power of pricing, to change corporate and consumer behaviour away from dirtier and more polluting activities and in favour of cleaner and less polluting ones. $23 is not a price that accounts for the true cost of carbon pollution, and many pollution permits will still be given away for free, but at least a price signal is finally going to be introduced, and the Greens have cannily negotiated a floor price which will stop the market from plummeting to investment-killing depths.

In reality, of course, the price will continue to rise as future governments place more stringent caps on Australia’s greenhouse gas emissions.

In the real world, markets are never truly efficient and all government policy must interact with the human actors in our society, from profit-obsessed corporations to risk-averse investors. That’s why yesterday’s announcement was more than simply a carbon price. It also included a number of important complementary measures that have made the policy much more likely to succeed, such as a $10 billion investment fund for clean energy, and a government buy-out of up to 2 gigawatts of dirty coal-fired electricity generation.

Some have already criticised the scheme for these complementary measures, deriding them as "picking winners", the typical catch-phrase of the lazy economist. In truth, the entire point of the policy is to handicap the current winner of the energy race — coal — because it is environmentally damaging. In this context, assisting some of the emerging renewable technologies constitutes sensible policy.

Another criticism is that the scheme allows Australian polluters to reduce their emissions by buying up credits for carbon abatement from overseas — by stopping a forest being felled in Papua New Guinea, for example. This is indeed a weakness of the scheme, as we’ll see below, but at least here the Greens have negotiated a 50 per cent limit on these overseas carbon credits. As long as these schemes are genuine (admittedly, a big concern), they constitute genuine global emissions. It may well be cheaper for an Australian company to buy up large swathes of tropical forest than to shut down a polluting smelter — but that doesn’t mean it’s a bad thing that a forest is being saved.

There is a broader issue here: the expectation that a price alone would do all the work was always an unrealistic one. This scheme employs a range of regulations and industry policies that better reflect the speculative and market-failure risks of market-based mechanisms, and also the reality that Australia’s economy is a mixed model in which government investments and regulations interact with the supposedly rational decision-making of profit-hungry corporations and investors.

In summary, therefore, there is every reason to believe this policy will work to reduce Australia’s carbon footprint, just as the detailed Treasury models predict. And that’s the whole point.

Why it’s better than the CPRS
Under Kevin Rudd, Labor had previously attempted to enact climate change legislation called the Carbon Pollution Reduction Scheme (CPRS). The Gillard package differs from the CPRS in several important ways.

In most aspects, the changes are for the better. The CPRS was a far "purer" emissions trading scheme, in which all the heavy lifting on emissions reduction was expected to be done by the carbon price itself. In contrast, the carbon tax announced yesterday includes important infant industry measures like the money for renewables R+D and finance. These measures are important, because there is an inherent flaw in market-based mechanisms which tends to bias investment decisions away from longer-term technologies and towards those technologies that already work right now.

Because of this, the CPRS would have seen most of the investment directed straight into wind, whereas this policy has a mechanism to support the development of genuine baseload renewable power, such as large-scale collecting solar thermal or geothermal technology.

The CPRS was also vastly over-generous to affected polluting industries like coal and steel. This package has less over-compensation, and will seek to eventually put that assistance under an evidence base, examined by the Productivity Commission.

The CPRS also mandated, long-term and inflexible targets (or "gateways") out to 2020, whereas this scheme allows future governments to be more flexible.

Finally, the CPRS reflected a 2050 emissions reduction target of 60 per cent, which was never in accord with the science of how far Australia needed to decarbonise. This carbon tax has moved the target up to 80 per cent. That’s excellent.

Why it’s fair
The Murdoch tabloids are already campaigning against the carbon tax on the spurious grounds that it will "hurt families", but in fact this policy’s combination of carbon pricing and clever tax reform is its strongest aspect. Wayne Swan and the Labor government have taken the opportunity raised by climate change to introduce many positive and progressive measures in the tax system that will benefit the poorest Australians most.

The tax-free threshold has been tripled, and because of tweaks to the Low Income Tax Offset, an Australian low-income worker will now pay no tax until she earns $21,000 a year. There are other measures in terms of increased family payments, pensions and tax cuts up to $80,000 which should all be supported by those who seek to reduce inequality and increase opportunity for Australians. This is a genuine example of using the proceeds of carbon taxation to support the most deserving, and Swan should be commended for it.

Treasury says the price rises resulting from the tax will be modest in most essential costs of living. In the case of electricity, for instance, price rises due to carbon pricing will be smaller than those already experienced in the last few years (which have nothing to do with carbon and everything to do with passing on the costs of upgrading transmission infrastructure). No wonder ACOSS and most welfare groups support the policy: it might even make Australia a fairer society at the same time it helps to reduce our reliance on fossil fuels.

The drawbacks
There are two key negatives to this policy: the over-compensation of dirty industries, and the potential for abuse of foreign carbon credits.

Of course, our view of compensation tends to be influenced by what industry we happen to work in. Truck drivers are already unhappy with their deal, worried that they will lose their current tax exemptions after two years, while big coal is predictably furious about the policy’s decision to give gassy coal mines "only" $1.3 billion. The government also plans to give the steel industry extra money, despite being opposed in this by the Greens; the reasons appear to have much to do with factional maneuvers by ALP-affiliated steel unions rather than the true impact of a carbon price on Australia’s already uncompetitive steel industry.

The potential for the abuse or financial manipulation of overseas carbon credits is a more troubling flaw. The whole conceptual basis for carbon abatement credits is potentially dubous, relying on "saving" carbon emissions from being emitted that none-the-less may still find their way into the atmosphere — for instance if a forest claimed as a credit today is later cut down in 2051. This area will require extremely careful regulation to prevent it from being distorted by financial innovators like the Macquarie group, who already have substantial experience in trading and arbitraging carbon credits, and could potentially use lightly regulated abatement schemes in poor countries to flood the Australian market with cheap carbon credits.

Julia Gillard gave a commitment that this would not be allowed to happen in her press conference yesterday, but the price of foreign credits will need constant vigilance of a kind that Australian financial regulators have not always displayed.

The politics
For Tony Abbott and the Coalition, the going has suddenly got a lot tougher. This is a package that extends significant tax cuts to the lower and middle classes and which will be almost impossible to unscramble even if the Coalition wins office in 2013. The Opposition’s completely implausible "direct action" policy has already come under greater scrutiny for the shambolic joke it really is, and Abbott and his frontbench will now be much less able to reflexively oppose everything the government says and does. The Opposition has had a dream run in the media since Abbott gained the leadership, but that can’t last forever.

Politically, the real winners yesterday were undoubtedly the Greens. By engaging with the government they have strengthened and improved the eventual legislation — showing themselves to be adept operators in the crafting of policy in the process. Some have suggested that the Greens’ increased visibility and role will lead to greater scrutiny and fewer votes at the next election — but the history of progressive parties in both Europe and Australia suggests that gaining experience in government is an important step towards being trusted by voters with greater responsibility.

Despite this, the focus should not be taken away from the Prime Minister. This is a huge win for Julia Gillard and her negotiating team. Gillard has struggled since becoming Prime Minister, but the contrast between her dismal standing in the polls and her growing list of policy achievements is starting to sharpen.

Certainly many of the most rigorous aspects of yesterday’s announcement bear the mark of Christine Milne and her superb command of climate policy — just as Tony Windsor is surely responsible for some of the smarter regional and rural aspects of the policy. But it was Julia Gillard and Greg Combet’s ability to sit down with the Greens and independents and work through a comprehensive policy process that led to yesterday’s achievement.

And an achievement is surely is. This really is a policy reform that will last decades and stand Australia in good stead. It’s every bit as significant in Australian terms as the passage of health reform was for Barack Obama and the Democrats in the United States last year. Whatever the eventual fate of the Gillard government — and they must still be considered unlikely to be re-elected in 2013, at least on current opinion polls — this package will become the defining accomplishment of Gillard’s political career. That is, assuming it passes, which the numbers suggest it will.

I’m sure no-one in the government believes the politics of this carbon tax will be easy, but the long-awaited announcement of the details must be heartening for the government’s beleaguered supporters. If Labor really goes out and sells this policy as it insists it will, this will be the first step down the long road to re-election.

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